By Rodney Dickens*

It was pleasing to see that at the same time as hiking the OCR 0.25% to 3% on 29 July, Governor Bollard stated that further increases would be less than previously expected.

However, there is still a fundamental and glaring error in the RBNZ’s assessment of economic growth prospects.

To be kind to the RBNZ, all the 10 economic forecasters surveyed by NZIER in June are making the same mistake. In contradiction to how things actually work, they are predicting significant increases in interest rates and robust growth in residential building activity.

Not surprisingly, a leading figure in the residential building industry – Richard Carver, Director of Jennian Homes – has taken the RBNZ and the economic forecasters to task over their residential building forecasts. Here is his media release.

And this is not a case of sour grapes.

Our leading indicator analysis, which has a fantastic track record at picking the near-term outlook for residential building among other things, has identified the risk of an imminent and significant fall in the number of consents for new dwellings over the next two quarters.

The first chart below shows the number of house sales reported by REINZ each month as a useful leading indicator of the number of consents for new dwellings (excluding apartments), with the red house sales line advanced or shifted to the right by six months reflecting the lead house sales have had over consents since the consenting process was altered in 2004/05.

The next chart below shows the number of REINZ section sales as an equally useful leading indicator of consents, with the red section sales line advanced by five months (i.e. providing a prediction for consents over the next five months).

The tumble in house and section sales over the last couple of quarters point to the risk of significant downside in the number of consents for new dwellings over the next couple of quarters.

These charts make a mockery of the economists’ forecasts for residential building, which in turn makes a mockery of their interest rate forecasts There is more to the story than the economic forecasters having a topsy-turvy view of the relationship between interest rates and residential building activity, and them not understanding how people are responding the housing affordability nightmare.

The initial indications are that the changes in property tax introduced in the Budget will have the same impact on housing activity as a 1-1.5% increase in mortgage interest rates.

If this proves to be the case it hugely undermines the need for the RBNZ to hike the OCR over the next 6-12 months.

The key question seems to be not whether this will halt OCR hikes, but how quickly Governor Bollard will realise that the RBNZ’s forecasts for residential building activity and economic growth are still way too optimistic.

See a full version of this 'Rodney's Raving' here.

Why the economists are so wrong

So what is going on with the economists’ residential building forecasts and why can they be so, so wrong! Having many, many years ago started my career as an economists working at the RBNZ, including having been involved in building a version of the RBNZ’s forecasting model, I have seen first hand what really drives the central bank’s economic forecasts. While the bank economists in general don’t even have proper forecasting models and when it comes to predictions for the likes of interest rates and residential building have a tendency to “flock”.

When it comes to interest rate forecasts (and exchange rate forecasts) the economists almost without exception predict that they will revert back to around the historical average or mean. All they are doing is predicting that the 90-day bank bill yield will increase to around the historical average level. There is no science in this, just an assumption that things will return to “normal”. The same thing is driving the economists’ residential building predictions (i.e. on average they are predicting that the level of residential building activity returns to around an average level over the next two years).

But we live in the aftermath of a speculative bubble in house and section prices that still hasn’t burst, associated with the housing bubble is stacks of debt, and we are still living in an environment in which the international financial crisis is having and will continue to have a major impact.

In short, to assume that the level of housing activity and interest rates will return to “normal” or average levels is either naïve or dumb, but probably both. As covered in the Housing Prospects reports, house prices remain extremely high compared to incomes (chart below).

This is giving people the incentive to economise on housing (e.g. young people/couples stay at home longer or move back home; people take in boarders to help pay the rent/mortgage; people convert garages to living quarters; retired people hit by finance company failures move in together).

In the 2006 Census there were 2.46 people per house on average. If the number of people per house increases to just 2.5 it means that roughly 26,400 less houses are needed.

Housing shortage a myth

This is what is currently going on in NZ and is why, as Richard Carver says, “The predicted housing shortage, at this stage, appears to be just a myth”.

It is just a myth even if some of the economic forecasters don’t realize it yet.

People responding to a major incentive, like extremely expensive housing, is the sort of thing that economists are taught should happen when they study at university, but for some reason they are too willing to assume this sort of behaviour away in their desire to predict that things will return to “normal”.

The housing market isn’t the be all and end all of economic growth. The story at the moment is about the economic recovery that started in the housing market and export sector filtering around the economy.

This is the “broadening” of the economic recovery driven by the “economic multipliers” of text book economics we discuss in the Interesting Times reports. However, as this chart below shows, cycles in residential building activity are critical swing factor in economic growth cycles.

If residential building activity falls significantly, economic growth will slow significantly.

Residential building on its own doesn’t make up a large share of economic activity – only 3.6% in the year to March 2010 (normally around 5%) – but it feeds many other industries including significant parts of the manufacturing sector.

If residential building activity falls as much over the next few quarters as the fall in the number of REINZ house and section sales are predicting, negative economic multipliers will start filtering around the economy over the next coupler of quarters. This means that economic growth will be well below the 3.6% predicted by the RBNZ for the 2011 calendar year.

Property tax changes mean few OCR hikes are needed

But there is more to the story than the economic forecasters having a topsy-turvy view of the relationship between interest rates and residential building activity, and them not understanding how people are responding the housing affordability nightmare.

The changes in property tax introduced in the Budget have had the same impact as a 1-1.5% increase in mortgage interest rates, which hugely undermines the need for the RBNZ to hike the OCR over the next 6-12 months.

Why has the number of house sales reports by REINZ tumbled back towards the trough levels experienced during the 2008 recession?

There is an inverse relationship between the number of house sales and the average mortgage interest rate.

More than just interest rates drive house sales, but interest rates are the most important cyclical driver.

If all other factors are stable, a 1% (one percentage point) increase in the average mortgage interest rate will result, with around a three month lag, in a 1,150 drop in the number of houses sold each month.

In that context, part of the sharp fall in the number of house sales this year can possibly be attributed to the earlier increase in the average mortgage interest rate.

However, with floating and short-term fixed mortgage interest rates remaining low, the increase in the average mortgage interest rate driven by rising medium-term and longer-term fixed mortgage rates, shouldn’t have had as large an impact as normal.

And even if we assume the increase in the average mortgage interest rate had the normal impact, it still only explains around half of the fall in the number of house sales.

Falling net migration is part of the story, but the main candidate for the fall in house (and section) sales is the property tax issue. It came to prominence early in the year and we have no doubt drove the tumble in the number of sales in January, when investors took fright at the prospect of tougher tax treatment of property investments.

In our assessment the property tax changes have had the equivalent negative impact of a 1-1.5% increase in the average mortgage interest rate.

RBNZ 'way off the mark'

If the fall in house and section sales is roughly mirrored in the number of consents for new dwellings over the next couple of quarters then the RBNZ and economic forecasters will have to make major revisions to their residential building, economic growth and interest rate predictions (i.e. life will go on a normal).  

The key question at the moment is not whether this will halt OCR hikes, but how quickly the RBNZ will realise that its forecasts are way off the mark even after suggesting they have downgraded them on 29 July.

We discuss this in detail in the Interesting Times reports and the Monetary Policy Briefing reports, which provide the best available insights on things like economic growth and interest rate prospects, why we don’t expect short-term wholesale interest rates to increase anywhere near as much as the economic forecasters are predicting.

Contact Rodney if you want to know more about any of our reports, while if anyone wants to know what really drives economic growth there are some spaces still available at the Economic Workshop he is running on 3 August (see here for info).

* Rodney is the MD of Strategic Risk Analysis, which prepares and sells reports on housing, construction, monetary policy and exchange rates. He produces a regular 'Rodney's Raving' which is available on his site here.

Sign up for his regular ravings here.

The slow release drench capsule was a revolution when first launched, and spectacular results were seen.

But one issue always worried me,and that was the effect of used plastic capsules left behind in an animals gut.

It seems the scientists are also concerned as this article illustrates, with a big investment being made to produce a biodegradable bolus dispenser.

In the future this could also be used, to dispense agents that prevent methane  being expressed in animals, to help minimise greenhouse gas into the atmosphere.

The Foundation is investing $2.1 million into NZ company Argenta Ltd to support the development of an improved device to administer multiple doses of drugs to sheep and cattle. The device is expected to lower costs to farmers worldwide reports Scoop.

The investment by TechNZ, the Foundation’s business development programme, will help Argenta Ltd to commercialise a bolus (drug delivery device) that is fully degradable, unlike current commercial boluses with hardware components that remain in an animal’s stomach.
 

The initial outcome of the TechNZ investment will be an anthelmintic (parasite-killing) sheep and cattle boluses, but the applications of the new technology could also extend to the delivery of greenhouse gas control products to ruminants. Richard Bentley, Foundation Group Manager, Manufacturing & High Growth Firms, says the investment will lead to increased revenues to New Zealand.

Argenta Ltd Chief Executive Dr Doug Cleverly says a degradable bolus system that leaves no residue in the animal has strong appeal particularly in the European Union, one of the company’s target markets. A degradable bolus that can deliver multiple drugs over 100 days appeals to farmers because of the increased animal health benefit, and because of the reduction of labour needed.

Sensitivity to animal welfare issues is becoming an increasing important part of farm management.

Statutory and industry bodys have created welfare codes that set minimum standards for the animals we farm, and farmers must understand and obey them or suffer the consequences.

Bobby calf animal welfare issues have been highlighted on this website before, and the response to a video record was dramatic.

Damage done through poor care can do huge damage to public perceptions of the industry, and the products we market.

Because of inductions, lack of value, and vunerability to disease of the suckler calf, this animal's welfare is more vunerable than other animals farmers raise.

The Ministry of Agriculture and Forestry (MAF) is planning proactive animal welfare work in the bobby calf area this season, starting Monday. Building on from a similar programme last year, MAF's Animal Welfare Investigators will be working in conjunction with industry groups such as the Road Transport Association, NZ Veterinary Association, Fonterra and Fed Farmers to expand on efforts to engage with farmers about bobby calves and provide advice.

Alan Wilson, Team Manager Animal Welfare Investigations says "Calving season is upon us and ultimately, we need farmers, and all those involved in the process chain, to be aware of their obligations under the Animal Welfare Act and follow best practice guidelines for the management of calves".Non compliance with the Act is unacceptable and animal welfare is a serious priority.

Alan says the purpose of the programme is to gather field information about bobby calf care and selection pre transport; feeding; and euthanasia. MAF visited more than 200 farms during last years programme of work and is looking to increase that number this year, including revisiting and re inspecting those farms found to have poor bobby calf practices last year.

For more information about industry best practice guidelines for bobby calves click here to visit the DairyNZ website.

Here are my Top 10 links from around the Internet at 10 past 1pm brought to you in association with New Zealand Mint for your afternoon reading pleasure.

I welcome your additions and comments below, or please send suggestions for Monday's Top 10 at 10 via email to bernard.hickey@interest.co.nz.

I'll pop any surplus suggestions I get into the comment stream under the Top 10.

1. The drums are beating - It's just a matter of time, it seems, before the US Federal Reserve starts massive money printing again in the form of buying US Treasury bonds with money created out of thin spreadsheets.

Here St Louis Fed President James Bullard (with a U not an O) is reported by Bloomberg as saying America must start fire up QE II (the second round of Quantitative Easing).

Here's Bullard's full speech on the 'Seven faces of the peril', referring to the risk of a Japanese style deflation for the US economy.

“The U.S. is closer to a Japanese-style outcome today than at any time in recent history,” Bullard said, warning in a research paper released today about the possibility of deflation. “A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.”

Fed policy makers are considering what actions to take, if any, to spur growth and reduce unemployment should the economy weaken further. Chairman Ben S. Bernanke told Congress last week the Fed could use communication to plot the path of interest rates, cut the rate it pays banks on excess reserves or purchase more bonds.

The Fed signaled last month that Europe’s debt crisis may harm U.S. growth and repeated a pledge to keep interest rates near zero “for an extended period.”  

2. A couple of useful quotes from a long time ago - Some of you will have seen these quotes from Thomas Jefferson, but they are worth repeating. HT David via email.

"I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale."

"The end of democracy and the defeat of the American Revolution will occur when government falls into the hands of lending institutions and moneyed incorporations"

3. When will the penny drop? - The bond vigilantes are dormant in America right now. The US 10 year Treasury bond is at 3%. But what happens when Mr Market wakes up and starts punishing the US for its profligacy.

The drums are beating here too, with Moody's, that paragon of virtue, telling Dow Jones that America's AAA rating will come under scrutiny unless someone (anyone please) comes up with a credible plan.

He said the U.S. appears to have "no plan" to deal with its fiscal situation and much will depend on the domestic political reaction to recommendations due by December from President Barack Obama's commission on fiscal responsibility.Measures which could be proposed include cuts to social security and medicare and the possible introduction of new taxes, Hess said.

"The question then is can they get the votes in Congress to implement any of them, so there is political uncertainty over the ability of the government to actually stabilize the debt levels or reverse the debt trajectory," he said.

He cited examples such as New Zealand, Sweden, Ireland and Canada which in previous decades succeeded in pulling down their debt levels.

"Can the United States do it is the big question right now and we are not sure either way. We will wait and see what happens in the next couple of years on this front."  

4. Some curious demographic projections - Just imagine a world in 2050 where Pakistan, Indonesia, Indonesia and Bangladesh had combined populations of 1.2 billion, making them the 4th, 5th, 6th and 7th most populous in the world behind India, China and America. That's the forecast in this Population Reference Bureau report. Fascinating reading with big implications.

Big population growth is expected in developing countries, particularly Muslim ones, while populations are likely to fall in developed economies. Mass migration anyone?

5. The Big Basel Backdown - Floyd Norris writes in the New York Times about what really happened in that meeting in Basel this week to decide on tougher rules for banks. Last year the Basel committee promised a crackdown. This week they delivered more backdowns than crackdowns.

It seems to many to be an anticlimax. There was no solid countercyclical proposal. There were backtracking and delay on major parts of the December proposals. The concessions appeared to be aimed at pacifying upset bankers. In December, the Basel committee said that some kinds of dubious “assets” simply could not be counted as part of capital. High on that list was something called “deferred tax assets.” If you don’t understand what that means, it basically is the money a bank will save on taxes when it earns profits in the future.

It is hard to think of an asset that would be less useful in a crisis, but there are others that could be of little use, like nontraded stock in a related financial company. Mortgage servicing rights — the value of a bank’s rights to collect and pass on mortgage payments — also could be hard to monetize in a crisis. In December, none of those assets were to be counted in capital. Now all can be, albeit to a limited extent. Apparently Japanese banks really needed to count the deferred tax assets, Europeans were eager to get credit for shares in related insurance companies, and American institutions wanted to count their mortgage servicing rights.

When it comes to liquidity rules, the revisions greatly soften the assumptions the previous rules made about how severe a crisis might be, and therefore make it easier for banks to appear to be perfectly liquid. The long-term liquidity rules, aimed at dealing with a prolonged downturn, may never see the light of day. They are to be studied and pondered and delayed. If details are ever agreed, they are to take effect in 2018. By then, if history is any guide, there will have been a new, and different, crisis to deal with.  

6. Financial reform 'Whack a mole' - The Economist reports here on how Goldman Sachs plans to get around the Volcker Rule passed through the US Congress just weeks ago. The rule was supposed to stop investment banks like Goldman Sachs from using their 'To Big To Fail' government guarantee to gamble on the markets on their own account through their proprietary trading desks.

Now they have a solution... These guys aren't paid the big bucks for nothing.

The firm will basically move its proprietary trading team to its asset management division where traders will have access to Goldman's clients. By reclassifying traders as asset managers and allowing them to take positions on behalf of clients, even one client, the bank circumvents restrictions around proprietary trading.

As Charlie Gasparino says: "Goldman’s move also underscores the weakness in the Volcker Rule, which was designed to reduce the same type of risk-taking activities that led to the 2008 financial meltdown. Simply by labeling a trade “customer related” the firm can still make large market bets, and thus engage in some of the same risk taking the rule was designed to eliminate. "

With the right incentives, markets will always figure a way around restrictions. But this seems a little too soon.  

7. No more shitty deals - Goldman Sachs has banned the use of profanities in emails, The Wall St Journal reports.  They're not paid all that money to be rude, it seems. They're paid a lot of money not to say embarassing things that eventually end up in the hands of legislators after discovery.

THERE will never be another "shitty" deal at Goldman Sachs Group, at least not in writing. The New York company is telling employees that they will no longer be able to get away with profanity in electronic messages.

That means all 34,000 traders, investment bankers and other Goldman employees must restrain themselves from using a vast vocabulary of oft-used dirty words on Wall Street, including the six-letter expletive that came back to haunt the company at a senate hearing in April.

“(B)oy, that timberwo(l)f was one shitty deal,” wrote Thomas Montag, who helped run Goldman's securities business, in a June 2007 email that was repeatedly referred to at the hearing.

Mr Montag, who couldn't be reached for comment, wouldn't be allowed to send that e-mail under Goldman's sanitised communications policy, which is being enforced by screening software. Even swear words spelled with asterisks are out. In the spirit of the times, there is no written directive specifying which curses are now officially cursed. But screening tools being used by the firm would detect common swear-words and acronyms. 

8. Burning a waka full of cash - Telecom CEO Theresa Gattung famously said once that she had burnt her waka on the beaches in Australia, suggesting Telecom was in Australia for good. Of course, Telecom is now selling AAPT. I couldn't help but remember this song below when reading about AAPT. The Australian reports that Telecom looks like it has lost around A$2 billion in its 10 years in Australia.

That is only partly offset by the bumper NZ$2.2 billion it received two years for its other dog, Yellow Pages, which is now likely to fetch around NZ$700 million in the fire sale being organised at the moment by the banks to the private equity firms that was managing money from the poor old Ontario Teachers Pension fund.

9. Wondering what might happen to interest rates in the next couple of years - Have a look at what the Economist is saying the European banks will have to raise in the next couple of years.

Does anyone really think this can be done without longer term interest rates for bank debt rising globally?

Even confident investors, however, may balk at how much debt they will soon be asked to buy. Euro-zone and British firms have €3.3 trillion of bonds to refinance by 2015, three times more than America’s banks. That reflects in part the European banks’ greater size, but also the fact that many countries have more loans than local deposits and some banks’ habit of owning dollar-denominated assets without gathering dollar deposits to fund them.

In the boom it was easy to fill the gap by tapping American money-market funds or securitisation markets.

But they won’t recover their appetite any time soon. Making matters worse, some banks are now competing against their governments, which need to sell piles of debt too.

10. Totally relevant video - Samantha Bee from The Daily Show flirts with a banker and asks some fund managing nuns and priests about Goldman Sachs doing the work of god.

House building increased 3.5% in June on a seasonally adjusted basis, Statistics New Zealand says, following a 9.5% fall in May.

Consents were issued for 1,373 new dwellings including 57 apartments in June. 

For the June 2010 year, 15,384 new housing units, excluding apartments, were authorised. Although that's a 25% rise versus the June 2009 year, it's the second lowest annual June year total since Statistics New Zealand began its series in 1991. The June 2009 year was the lowest.

"In the June 2010 year, 783 new apartment units were authorised, which is the lowest since 1994," Statistics New Zealand's business statistics manager Louise Holmes-Oliver said.

The monthly trend for the number of new housing units authorised, excluding apartments, has been increasing since early 2009, but the level remains 31% down on the June 2007 peak.

ASB economist Jane Turner said the Reserve Bank had noted a weaker net migration outlook in yesterday’s Official Cash Rate announcement. It was likely therefore to have incorporated a weaker outlook for housing construction in recent forecasts.  

"Indeed, in light of the slightly softer growth outlook the Reserve Bank noted that the pace and extent of future policy tightening is likely to be more gradual than expected.  Nonetheless, the New Zealand economy is still on track for a modestly paced recovery. In contrast to previous cycles, this recovery is set to be export led, while the household sector (including the residential construction industry) is likely to remain relatively subdued."

Meanwhile, Statistics New Zealand said the value of dwelling alterations and additions was NZ$109 million in June, the highest monthly figure since the series began in January 1991.

The value of residential building consents was NZ$508 million, 32% higher than June 2009.

The value of non-residential building consents was down 26% for the month of June - versus June 2009 -  to NZ$228 million. The biggest falls came in education buildings down NZ$39 million, storage buildings down NZ$32 million and offices and administration buildings, down NZ$25 million.

The largest increase was for shops, restaurants, and taverns, which increased NZ$13 million.